Stocks post solid gains on U.S.- China trade truce, more talks

Stock market corrections, although painful at the time, are actually a very healthy part of the whole mechanism, because there are always speculative excesses that develop, particularly during a long bull market. – Ron Chernow, American writer and journalist

Despite the fact that President Donald Trump and Chinese President Xi Jinping did not reach a trade agreement at the G-20 summit meeting, the stock market behaved like they did and finished the week with solid gains. All three major averages closed at least 1% higher and came close to ending the week at all-time highs. One can only imagine how the market will react if a trade deal between the two countries is actually reached. Instead, investors were relieved that there were no new tariffs imposed on each other and encouraged by the prospect for additional negotiations between the two sides. Even Chinese tech giant Huawei Technologies was granted a reprieve as U.S. companies were again allowed to sell their products to the company. In addition to this perceived good news on trade, the stock market continued to benefit from the apparent dovish stance on interest rates by the Federal Reserve. Investors now believe that there is an increased likelihood of a cut in the federal funds rate of at least 25 basis pints when the Fed meets in July. (A basis point is one hundredth of one percent.) While recent economic data has been relatively soft and would provide justification for a 50 basis point cut, the strong June employment report  released on Friday would seem to counter that argument. The report showed that 224,000 new jobs were created, far more than the 165,000 that were expected and much higher than the number of jobs created in May. But the unemployment rate edged higher to 3.7% from 3.6% and wage growth was slightly lower than expected. It remains to be seen how much importance the Fed places on this one report. Inflation has been running below the Fed’s 2% target and with the forecast of slower economic growth, a Fed rate cut in July seems more likely. There still is no clear path toward a comprehensive trade deal and corporations have difficulty making investment decisions with so much uncertainty. This gives the Fed yet another reason to justify a rate cut.

Last Week

A precursor to the government jobs report is the ADP report on private payrolls, which showed a gain of only 102,000 jobs in June, which was less than the 135,000 that were expected. The ISM manufacturing index in June fell but was slightly better than expected while the ISM non-manufacturing or services sector index also declined from its level in May. U.S. construction spending dropped in May and showed the biggest decline since last November while factory orders in May also fell and were worse than expected. All of this weak economic data seems to strengthen the Fed’s case for a rate cut later this month.

The U.S. government threatened to impose tariffs on $4 billion of additional European goods in a long-running dispute over aircraft subsidies given to Boeing and European rival, Airbus.

For the week, the Dow Jones Industrial Average rose 1.2% to close at 26,922 and the S&P 500 Index gained 1.7% to close at 2,990. The Nasdaq Composite Index jumped 1.9% to close at 8,161.

This Week

Both the producer price index (PPI) and the consumer price index (CPI)) for June are expected to show little or no increase and confirm that inflation remains benign.

Federal Reserve Chairman Jerome Powell delivers the semiannual Monetary Policy Report and testifies before both the House and the Senate. The Federal Open Market Committee (FOMC) also releases minutes from its monetary policy meeting in June.

Second quarter earnings season begins this week but the only prominent companies scheduled to report are PepsiCo and Delta Airlines.

Portfolio Strategy

All eyes and ears this week will be focused on Federal Reserve Chairman Jerome Powell as he presents his semiannual report on monetary policy before Congress. While the inflation data this week will also be of importance, it is likely it will confirm what we already know – that inflation is running well below the Federal Reserve’s target of 2%. The Fed’s preferred measure of inflation, the personal consumption expenditures (PCE) index, was only 1.6% through the end of May and both wholesale and consumer prices in June are expected to be flat to only slightly higher. Powell has already indicated that the Fed stands ready to lower interest rates in order to maintain the current economic expansion, which is now the longest in history as growth is now in its 121^st month. With bond yields low and the yield curve inverted with the 3-month Treasury Bill yielding more than the 10-year Treasury Note, fears of slowing economic growth and even a recession have crept into investors’ minds. The federal funds futures market is currently forecasting an all but certain quarter-point cut at the July 31^st FOMC meeting, which would put the federal fund rate in a range of between 2% and 2.25%. Unless there is a trade agreement reached between the U.S. and China prior to the Fed meeting, such a rate cut looks to be a foregone conclusion. Testimony by Fed Chairman Jerome Powell on Wednesday could go a long way toward determining the Fed’s action when it meets at the end of the month.